What is Luxury Tax?
The luxury tax is a tax obtained from people purchasing expensive goods or services that offer luxury and are typically not perceived as essential goods. They are seen as goods that are not essential for the survival of the people, unlike cereals, blankets or medicines.
It is collected from higher income groups as a progressive taxProgressive TaxProgressive tax refers to the increase in the average rate of tax with the increase in the amount of taxable income so that the liability of paying heavy taxes passes to those who earn a higher income and those with lower income can have a relaxation from the heavy income tax obligations. on certain purchases. The amount so generated helps to increase revenue, lower budget deficitsBudget DeficitsBudget Deficit is the shortage of revenue against the expenses. The budgetary deficit could be the sum of deficit from revenue and capital account. , and pay for other government expenses. In 1991, the US had imposed this tax on some commodities as a part of a financial plan to decrease the federal budget deficit.
Table of contents
- Luxury tax refers to a form of indirect tax imposed on luxurious goods and services which are expensive in nature such as resort services, private jets, expensive cars, etc.
- Some goods or services are easily affordable for the wealthy and as such, many believe that they should have their fair share to pay in taxes. By imposing taxes on items or services accompanying exorbitant rates, many governments have tried to gain additional revenue.
- It is endowed with the idea that due to its progressive nature, the low-middle income groups will not bear the brunt of such tax collections.
- However, higher taxes have often led to a fall in the demand of goods and services, affecting the working-class or lower-income people in the form of job loss.
How does Luxury Tax Work?
The luxury tax is an example of progressive taxation, which extracts more tax from wealthy people or people who can afford it. Proponents of this idea believe that rich people can contribute to the nation’s financial health by paying a tax on certain luxurious purchases.
It is an indirect taxIndirect TaxIndirect tax, also known as consumption tax, is the type of tax the person does not directly bear. In contrast, the incidence of such taxes is passed on to the end consumer of goods or services by adding such taxes to the value of those goods or services, like Excise duty, Service tax, VAT, etc. usually imposed if the cost of goods or services surpasses a given threshold. It is usually a part of value-added taxValue-added TaxValue-added tax (VAT) refers to the charges imposed whenever there is an accretion to a product's usefulness or value throughout its supply chain, i.e., from its manufacturing to its final selling point. It is an indirect tax levied on the product consumption. (VAT), sales taxSales TaxThe government levies sales tax on the consumption of various goods and services as the percentage added to the product and services from which the government earns revenue and does the company's welfare. In the United States, 38 different states have different taxes, from Alaska (1.76%) to Tennessee (9.45%). or service tax. For example, in 1991, the US had levied a 10% luxury tax on cars priced over $30,000, boats above $100,000, and private planes above $250,000.
Following are some effects of such taxes –
- Increases the price of selected luxury items, mainly positional goods.
- Boosts government income.
- Decreases disposable incomeDisposable IncomeDisposable income is an important mechanism to measure household incomes, and includes all sorts of income such as wages and salaries, retirement income, investment gains. In other words, it is the amount of money left after paying off all the direct taxes. of wealthy people.
- Price hikes lead to a fall in demand as per the law of demandLaw Of DemandThe Law of Demand is an economic concept that states that the prices of goods or services and the quantity demanded are inversely related when all other factors remain constant. In other words, when the price of a product rises, its demand falls, and when its price falls, its demand rises in the market. and supply. Even with certain commodities that are inelastic and witness high demand after increased rates, most sector undergo declining sales with hikes. For example, in 1991 in the US, Yacht retailers took a hit as there was a 77% fall in sales due to tax hikes. Boatbuilders had to lay off 25,000 workers approximately. The taxes collected were $ 97 000 short of their projected number as the sales of these goods had declined enormously after increased costs.
- Triggers black market trading.
- Another significant implication is that it alters taxpayer behavior like many other excise taxes such as the gasoline excise taxExcise TaxExcise tax is the tax applied to the sale of particular goods and services like tobacco, fuel, and alcohol. It is not directly paid by an individual consumer, instead, the tax department levies the tax on producer or merchant of products..
List of Items Taxed as Luxury
Following are some common list of items that fall the luxury tax category –
- Expensive cars
- Private Jets
- Jewelry (including watches)
- Expensive Furs
- Real Estate (transaction above predetermined level)
- Wine & Champagne
Luxury Tax on Cars
In 1991, the US had levied an additional tax to help cover the federal budget deficit. Purchases of passenger vehicles priced at above $30,000 were subject to a luxury car tax, generally 10% of the original price. There were certain exceptions to the law exempting vehicles such as those for public safety, law enforcement, or public work by the federal, state, or local government.
During the 1990s in the US, the tax imposition resulted in decreased production and sale of many commodities. Luxury items like cars, boats and costly jewelry witnessed declining demand and sales. As a result, it affected the manufacturers and associated stakeholders.
Although the tax system’s purpose was to collect taxes from the ultra-wealthy, it impacted the working class. For instance, taxes on specific products, such as yachts, impacted the boating sector, resulting in job losses. The situation deteriorated to the point that the government had to repeal the law. The federal luxury automobile tax, on the other hand, was in place until 2002.
Luxury Tax in the NBA
The National Basketball Association (NBA) in the US has a cap structure for taxation and salary. However, both these caps have different values. For example, in 20-2021, The NBA and Player’s Association set the salary cap and luxury tax at $109.140 million and $132.627 million, respectively.
Since they have a soft salary cap structure, they can spend more than the specified limit but bear certain reduced benefits. As for taxes, they need to pay an additional amount if the NBA teams spend more than the predetermined tax threshold.
This method keeps the teams balanced and allows them to piece together a successful squad. Moreover, it grants fair formation processes, preventing rich teams from dominating the game and keeping the sporting spirit alive.
Luxury Tax on Tampons
The tax on tampons has been a controversial law since many people perceive it as unfair. It includes any taxes added to hygienic menstrual products. Tampon taxes are often laid on menstrual hygiene products either as VAT or additional tax as part of a non-exempt commodity.
The taxation of feminine hygiene products is changing across the world. For example, the UK has recently announced they would no longer be taxing these items. Countries offering zero tax on menstrual hygiene products include India, Australia, and Canada, etc.
Luxury Tax in Baseball
In baseball, the luxury tax seeks to keep the maximum amount a club may spend on payroll, and one can find these rates on websites of leagues such as the Major League Baseball (MLB). As a result, it prevents a single team from acquiring the majority of the best players.
Therefore, the league establishes a predefined amount, and if a team spends more than that, they are subjected to a competitive balance tax. The MLB in the United States follows a competitive balance tax system and can spend above the threshold but with an additional tax.
In addition, if the club spends more than the specified amount for three years in a row, the tax rate will increase substantially. According to the MLB website, the following MLB rates apply for teams that cross the payroll threshold consecutively in the first, second and third year.
- First-year – 20%
- Second-year – 30%
- Third-year– 50%
Some products around us are not vital for survival and can be readily substituted. When a tax is levied on expensive items that are an easier buy for high-income groups and paid only upon purchase, it is referred to as a luxury tax.
It is a progressive tax because it applies to a limited group of people who purchase specific high-priced items.
The tax is levied on luxurious and expensive goods and services such as jewelry, high-end cars, yacht, private jets, etc. For example, in 1991, the US had levied a 10% luxury tax on cars priced over $30,000.
This article has been a guide to What is Luxury Tax & its Definition. Here we discuss the features of Luxury tax and how does it work, along with examples. You can learn more about from the following articles –